Chapter 9 Flashcards
(9 cards)
What happens when real interest rate r makes the IS-LM equilibrium at output Y, causing a positive output gap?
The model would be in short run, working above natural level of output leading to a positive change in inflation, causing inflation to be increasing. This is not sustainable forever and the policy rate will be set so that the level of output = the natural level of output (medium run).
What is the goal of the central bank?
Maintaining price (or inflation) stability is either the main goal or one of the main goals of central banks.
It means that, if inflation increases or decreases too much, central banks will react by increasing or decreasing the policy rate.
Describe the steps the Central Banks takes when inflation is increasing (and economy is above natural level of output).
When the economy is above the natural level of output and inflation is increasing, the central bank will react by implementing a contractionary monetary policy.
By increasing the policy rate, the real interest rate will increase, and investment, demand, and output will decrease. We move along the IS curve and along the PC.
The central banks’ policy will bring the economy back to its natural level, the medium-run equilibrium. In A’, inflation is stable.
rn is the real interest rate that is associated with the natural level of output. It is called the natural rate of interest.
What happens when output is equal to potential?
The output gap is zero, the change in inflation rate is zero. Thus, PC crosses the horizontal axis at the point where output is equal to potential.
How would the CB have to respond to a boom in order to get back to the initial inflation rate?
The boom must be followed by a recession. See pg. 203.
What are anchored inflation?
When the inflation equals a constant, independent of last years inflation.
What are the two major increases in the real price of oil since 1970?
1970: formation or OPEC (able to work as a monopoly)
2000: fast growth of emerging economies, in particular China –> rapid increase in demand for oil.
What are the two major decreases in the real price of oil since 1970?
2008: drop in price at the end of the crisis –> large recession –> large sudden decrease in demand for oil
2014 and onwards: debated. Most observers believe it’s a combination of increase supply because of increase in shale oil production and breakdown of OPEC.
What does an increase in m mean on output and inflation?
Given wages, an increase in the price of oil increases cost of production which forces firms to increase prices to keep same profit rate.
